Beruflich Dokumente
Kultur Dokumente
9/14/2012
Foreword
While furnishing this report, I must duly acknowledge the role played by its
members, namely, Ms. Anita Kapur, DGIT (Administration), Delhi, Ms. Rashmi
Saxena Sahni, DIT (Transfer Pricing-I), Delhi and Mr. Dinesh Kanabar, Tax Expert
in analyzing the various data and showing a rare commitment and devotion.
I must also acknowledge with gratitude the important role played by the two
senior officers of the Department, namely Shri D. Prabhakar Reddy and Shri
Sobhan Kar, Addl. Commissioners of Income-tax, in assisting the Committee in
its deliberations and bringing into consideration relevant issues from time to
time.
N. Rangachary,
Chairman
14th September, 2012
Table of Contents
Part 1: Introduction 1- 6
Part 2: Approach to Taxation of Development Centres 7 - 28
Part 3: Income-tax Issues pertaining to the IT Sector 29 - 51
Appendix A: Importance of Development Centres 52 - 55
Annexure-I: Press release of Prime Minister’s Office dated
30th July, 2012 56 - 57
Annexure-II: Office Memorandum of Department of
Revenue, dated 3rd August, 2012 58 - 59
Annexure-III: CBDT order No. 154, dated 7th August, 2012 60
Annexure-IV: Press Note issued by the office of Hon’ble Finance
Minister, Shri P. Chidambaram, on 6th August, 2012 61 - 63
Annexure-V: Office Memorandum dated 8th August, 2012 of
FT &TR Division of CBDT 64
Annexure-VI: Other Transfer Pricing Issues raised by the
Stakeholders in relation to Development Centres 65
Committee to Review Taxation of Development Centres and the IT Sector
PART 1: INTRODUCTION
1.1 Prime Minister’s Office issued a press release on July 30, 2012
(Annexure -I), stating that the Hon’ble Prime Minister had constituted a
Committee to Review Taxation of Development Centres and the IT Sector
under the Chairmanship of Mr. N Rangachary, former Chairman CBDT & IRDA.
The press release also underlined the following grounds for seeking resolution of
tax issues through an arm’s length exercise in the form of a review by the
Committee:
• There is a need to address issues relating to the taxation of the IT Sector
such as the approach to taxation of Development Centres, tax treatment
of "onsite services" of domestic software firms, and also the issue of
finalising the Safe Harbour provisions announced in Budget 2010.
• The reason for large concentration of Development Centres in India is
the worldwide recognition of India as a place for cost competitive, high
quality knowledge related work. Such Development Centres provide high
quality jobs to our scientists, and indeed make India a global hub for such
Knowledge Centres. However, India does not have a monopoly on
Development Centres. This is a highly competitive field with other
countries wanting to grab a share of the pie. There is need for clarity on
their taxation.
• Safe Harbour provisions announced in Finance Bill 2010 but yet to be
operationalised have the advantage of being a good risk mitigation
measure and provide certainty to the taxpayer.
• A comprehensive approach involving consultations with the Government
departments concerned and the industry bodies is required.
• The overall goal is to have a fair tax system in line with best international
practice, which will promote India's software industry and promote India
as a destination for investment and for establishment of Development
Centres.
1.2 The press release indicated the following terms of reference and the
time lines for the Committee -
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Terms of Reference:
i) Engage in consultations with stakeholders and related Government
departments to finalise the approach to Taxation of Development Centres
and suggest any circulars that need to be issued.
ii) Engage in sector-wide consultations and finalise the Safe Harbour
provisions announced in Budget 2010 sector-by-sector. The Committee will also
suggest any necessary circulars that may need to be issued.
iii) Examine issues relating to taxation of the IT sector and suggest any
clarifications that may be required.
Time Lines:
i) Finalise the approach to taxation of Development Centres and suggest
any necessary clarifications by 31 August 2012.
ii) Suggest any necessary clarifications that may be needed to remove
ambiguity and improve clarity on taxation of the IT Sector by 31 August 2012.
iii) Finalise Safe Harbour Rules individually sector-by-sector in a staggered
manner and submit draft Safe Harbour provisions for three sectors/sub-
activities each month beginning with the first set of suggestions by 30
September 2012. All Safe Harbour provisions can be finalised by 31 December
2012.
1.4 The Committee sought and was provided assistance of two officers,
namely, Shri D. Prabhakar Reddy, Addl. Commissioner of Income Tax, TPO-II(6),
Mumbai and Shri Sobhan Kar, Addl. Commissioner of Income Tax (APA), Delhi
vide CBDT order No 154 dated 7th August, 2012 (Annexure-III).
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1.5 The time limit of August 31, 2012 for submission of recommendations of
the Committee on issues other than Safe Harbour was, with the approval of the
Finance Minister, extended to 15th Sept. 2012.
1.6 The rationale for setting up the Committee was, inter alia, reiterated in
the Press Note issued by the office of Hon’ble Finance Minister, Shri
Chidambaram on August 06, 2012 (Annexure-IV). The relevant part is extracted
below:
“Clarity in tax laws, a stable tax regime, a non-adversarial tax administration, a
fair mechanism for dispute resolution, and an independent judiciary will
provide great assurance to investors. We will take corrective measures
wherever necessary. We have recently appointed two Committees, one to
examine GAAR legal provisions and guidelines and the other to review
taxation of the IT sector and Development Centres. I have also directed a
review of tax provisions that have a retrospective effect in order to find fair
and reasonable solutions to pending as well as likely disputes between the Tax
Departments and the Assessees concerned. With these measures, and some
other measures that we hope to take in the short term, it is our intention to raise
the level of investment to 38% of the GDP that was achieved in 2007-08.”
1.7 Further, FT & TR Division of CBDT through Office Memorandum dated 8th
August, 2012 (Annexure-V), advised the Committee that the Hon’ble Finance
Minister had approved the suggestion that the issue of application of Global
Profit Method to determine arm’s length price of intangibles developed by the
R&D centres of MNEs in India may be considered by the Committee.
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1.9 The Committee received written submissions from most of the above
stakeholders. The Department of Electronics & IT primarily supported the
position of NASSCOM on various issues. The Department of Commerce
generally sought uniform, predictable and fair application of the tax laws
apart from supporting some beneficial construction of incentive provisions in
respect of certain contentious issues e.g “onsite service”, shifting of employees
to new unit and MSA vs. SoW.
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1.12 An interactive session was conducted on 19th August, 2012 with the
following business/industry chambers:
i. NASSCOM
ii. FICCI
iii. ASSOCHAM
1.13 An interactive meeting was also held on 3rd September, 2012 with the
following officers of the Income-tax Department/CBDT to ascertain the views
of the Revenue:
i. Chief Commissioners of Income-tax (CCA), Bengaluru, Chennai, Delhi,
Hyderabad and Mumbai.
ii. Director General of Income-tax (International Taxation), Delhi
iii. Joint Secretaries (FT & TR-I and II), CBDT
iv. Commissioner of Income-tax (ITA), CBDT
1.14 Another round of consultations was held by the Committee with the
following business/industry chambers on 12th September, 2012:
i. NASSCOM (including E&Y)
ii. CII (including Microsoft, Yahoo India, Wipro, Deloitte Haskins & Sells and
Amarchand Mangaldas)
iii. ASSOCHAM (including PWC)
iv. FICCI
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1.15 After going through the representations received from the various
stakeholders and giving due consideration to the perspective of the Revenue,
the Committee identified certain critical issues affecting the industry for its first
report on which action can be taken immediately.
1.16.2 The Committee has refrained from examining the issues raising
questions about the logic and rationale of the extant provisions of the Income
Tax Act and seeking amendments thereto, as the Committee is not mandated
to review the law.
1.17 Thus, this first report covers key concerns, as highlighted by the
stakeholders, relating to taxation of Development Centres (DCs) as well as
taxation issues of the IT Sector and completes the response of the Committee
to the first two terms of reference. Finalisation of Safe Harbour rules for certain
sectors including DCs, requires detailed data analysis and the Committee will
respond to this matter in its subsequent reports.
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2.2 Eight TP audit cycles have been completed and the transfer pricing
adjustments made are as follows1:
Financial year Number of TP Number of % of adjusted Amount of
Audits adjustment cases adjustment
completed cases (INR in crore)
2004-05 1,061 239 23 1,220
2005-06 1,501 337 22 2,287
2006-07 1,768 471 27 3,432
2007-08 218 84 39 1,614
2008-09 1,726 670 39 6,140
2009-10 1,830 813 44 10,908
2010-11 2,301 1,138 49 23,237
2011-12 2,638 1,343 52 44,531
2.3 Transfer pricing disputes are a major cause of concern for captive DCs in
India. The PMO’s Press Note dated July 30, 2012 defines captive DCs as under:
“Many MNCs carry out activities such as product development, analytical
work, software development, etc. through captive entities in India. They exist in
wide variety of fields including IT software, IT hardware, Pharmaceutical R&D,
other automobile R&D and scientific R&D. These are popularly called
Development Centres.”
1
“White paper on Black Money, May 2012” Ministry of Finance, Department of Revenue,
CBDT, New Delhi at page no. 59 and Para 4.7.1
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2.4 Transfer pricing is not an exact science. It is both fact intensive and fact
sensitive and does require exercise of judgment on the part of tax
administration and taxpayer. Administration of TP provisions relating to transfer
pricing documentation, comparability analysis, choosing and applying most
appropriate method to determine arm’s length price, continues to generate
litigation.
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software life cycle begins when an application is first conceived and ends
when it is no longer in use. It includes aspects such as initial concept,
requirement analysis, functional design, internal design, documentation
planning, test planning, coding, document preparation, integration, testing,
maintenance, updates, retesting, phase-out, and other aspects. Software life
cycle models describe phases of the software cycle and the order in which
those phases are executed. The stages of Software Development Cycle, using
the simplest model, which are based on sequential phases, are as follows:
i. Envision & Plan
ii. Design
iii. Develop
iv. Test
v. Deploy & Maintain
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2.9.5 Some portions of each of these activities are carried on from India
(Offshore) and other portions at the site of the customer or at the headquarters
of an MNC (Onsite). The proportion of onsite to offshore work for each stage
may differ from development centre to development centre.
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2.9.8 In the cases of captive R&D centres operating in India, it is not only that
the legal and economic ownership lies with the overseas principal R&D
Company, but it also has to be appreciated that any work product, the
patent registration, etc. if any, based on contribution by India cannot be
commercially exploited on a standalone basis because its contribution to the
overall value chain is insignificant. Such patent registration is only to safeguard
the legal rights of the principal against infringement of IP (by competitors),
however insignificant these rights be. The principal makes decisions with
respect to the following:
• Hiring/Terminating services of contract researcher
• Type of research to be carried on and assigning objectives
• Budget to be allocated for research
• Assessing outcome of the research....test, review & evaluate results
• Setting stage for decision making
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2.10.1 The DCs in India are engaged in R&D activities for development of new
product (including software development) and services, development of
design and development of part of product or services which go as input to
final product/services being developed by parent company.
2.10.2 These research and development activities may be classified into two
categories:
Primary function of R&D activity is to develop new
product/services or inputs.
Other function is to discover and create new technology, design,
methodology, for development of new product, process and services.
2.10.3 The models of R&D differ significantly. However, R&D is intended to yield
immediate profit or immediate improvement in operations and involves little
uncertainty in so far as the return on investment is concerned. The new
product development (services, design and inputs) is a crucial factor in survival
of the group because nowadays products/services are changing so fast that it
requires continuous revision or development of design, products and services.
Accordingly, the R&D activities are core to the survival of the group in the
competing market.
2.10.4 Different companies adopt different models and type of R&D activities
and ratio of research and development spending to the revenue varies
significantly. High R&D expenses are justified in the light of consequent high
gross margins varying from 60 to 90%.
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2.10.6 Analysis of the conduct of the parties is more important than the
written contract.
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The Committee has responded to the relevant issues in the context of the
discussion on the application of Most Appropriate Method.
2.13.1 Indian R & D Centres of MNCs are entitled only for appropriate cost-plus
return for the contract R & D work performed and not entitled to any
intangible related returns.
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2.13.4 Application of PSM by India will increase the overall cost of undertaking
R & D work in India though the quantification for the same would depend on
varied factors. Also, the lifecycle of an R & D program tends to be long
(average lifecycle of an R& D program exceeds two years) with new programs
starting regularly. Thus, an MNC looking to setting-up an R & D centre would
seek a greater degree of certainty of the tax policy applicable in order to
meet its long-term objectives. It is therefore imperative that transfer pricing
policies for R & D centres in India are carefully and pragmatically implemented
keeping in view that India would like to retain its competitive edge.
2.13.5 The complex transfer pricing issues need better understanding of the
larger R & D program of an MNC and a careful study of the functional analysis
in most cases would reveal that cost plus method would be applicable. Both
taxpayers and tax authorities need to work together to ensure that this
understanding increases quickly. In the meantime, the tax authorities need to
resist the temptation of using PSM on a generalized basis to drive revenue
collection when indeed the same would be grossly incorrect for most contract
R & D arrangements in India today.
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2.14.1 The position of Revenue as per the presentation made by JS, FT & TR-I,
CBDT during the meeting on 3rd September, 2012 before the Committee, is
summarised below:
• Off-shoring is no longer limited to standardized information and
technology but increasingly involve product development function
(engineering, R&D) and product design;
• Distinction between home-based and foreign-based development
centres has disappeared;
• These DCs are transferring labour, skill and innovation to another country;
• There is transfer of intellectual property and these DCs are unaware of
the value they are exporting;
• The FAR i.e. Function, Asset and Risk Profile of a DC will depend on
nature, business model, reasons and benefits of off shoring;
• Functions, Assets and Risks are equally important;
• Since risk is a by-product of functions performed and usage of assets, it
should be considered together with functions and assets;
3 Presentation cum Discussion on 3rd September, 2012 - JS FT&TR-I, CBDT and DGIT
(International Taxation)
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confirmed the approach of the TPO for the AY 2007-08 as the taxpayer
was not able to produce data and supporting evidence, within the time
available to the DRP, to demonstrate that any method other than PSM
should be applied on the facts and circumstances. In respect of AY
2008-09, the proceedings are pending as on date.
In one case for A.Y. 2008-09 the taxpayer has applied PSM as the
activities performed by the taxpayer and its affiliate were claimed to be
inextricably linked with both entities contributing significantly to the
value chain. However, considering the facts of the case, the TPO applied
TNMM .
Whenever industry refers to cost-plus or appropriate mark-up on cost,
reference is to profit margin under Transactional Net Margin Method on
cost. While applying TNMM on captives, the profit margin is computed
on the cost, excluding interest and tax. As most of the captives follow
cost plus business model, all the costs (before interest and tax) are
reimbursed by the principal, with certain agreed mark-up. The costs that
are considered (before interest and tax) for applying TNMM for the
captive and the comparables also form the cost base for reimbursement
by the principal. Thus, as per industry, appropriate mark-up on costs, in
effect refers to the appropriate operating margin under TNMM and cost
plus method referred by the industry, in effect is TNMM under the Income
Tax Act.
The characterisation of Research and Development function can
broadly be in three baskets, i.e., -
Full risk bearing developer
Limited risk bearing developer
Contract R & D service provider with no significant risks
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2.15.4 Contract between the principal and the DC is a relevant factor but not
the determinant factor. Conduct of the affiliate DC should be consistent with
the contractual terms with the Principal. For example, if a contract shows the
principal to be controlling the risk but conduct shows that affiliate is doing so,
then the contractual terms are not the final determinant of actual activities. In
the case of foreign principal being located in a country /territory widely
perceived as a tax haven, it will be presumed that the foreign principal was
not controlling the risk. However, the taxpayer may rebut this presumption to
the satisfaction of the revenue authorities.
2.16.1 The Income Tax Act read with Rule 10B (i)(d) (extracted below)
stipulates that transfer of unique intangible requires application of PSM:
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2.16.3 The Committee has also taken note of the fact that HMRC, UK has
recognised the following problems in application of PSM while issuing the
guidance in applying PSM4
i. There is a difficulty in isolating the controlled transactions and
establishing what functions add value along the product chain.
ii. The profits that are to be split should be based as far as possible on
projected figures for sales and costs that were available at that
time (replicating the probable negotiation process between two
independent parties). This can potentially involve trying to estimate
how a product is going to perform over a number of years.
iii. The potential for affiliates to produce any valuable intangibles has
to be carefully examined, along with risks of the R & D producing
nothing.
2.16.4 HMRC has also discussed how the cost of developing the intangible
has only an indirect link to the value of intangible5. The relevant portion of the
guidance is as follows:
“The expense of discovering and developing valuable intangibles has
no direct relation to the price of products manufactured and sold
using that technology. If the R & D programme cost £100 million, the
products will rarely be priced directly to try and recoup those costs
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over say the next 5 years. There is of course an indirect link; a business
will bear in mind the costs of its current R & D programmes for future
products, and what it would like to spend on that R & D in the future,
but the pricing of goods and services is subject to a very complex
interaction of many commercial factors. While a revolutionary new
product will no doubt attract a premium price in some markets, there
is generally a limit on what people are prepared to pay”.
2.18 General Transfer pricing issues which are not specific to the IT Sector
The stakeholders have identified some other transfer pricing issues affecting
the DCs including those which are not engaged in R&D. These issues are listed
in Annexure-VI.
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2.19.1 The Committee recognises that these Transfer Pricing (TP) issues impact
all sectors and are not peculiar to DCs or IT sector and considers their review
beyond its mandate. The Committee acknowledges that these issues do
create tax uncertainty but is of the view that most of these arise due to lack of
consistency and proper FAR analysis in the application of transfer pricing
provisions. Hence, there is certainly an urgent need to have internal clarity and
consistency on these issues.
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provisions in the Income Tax Act. However, the Committee has, considering its
mandate, not examined those.
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3.1 The Committee has, after long deliberations and careful consideration of
all the issues, arrived at a set of recommendations consistent with its approach
summarized in paragraph 1.16. The issues and recommendations are detailed
in the following paragraphs:
3.3.1 Industry representatives have asserted that the Indian software export
industry is the child of the concept of globalization. They have explained
globalization as something that is about sourcing capital from where it is the
cheapest; sourcing talent from where it is best available; producing where it is
most cost-effective; and selling where the markets are, without being
constrained by the national boundaries. According to them, the Global
Delivery Model, which has become the de-facto standard for the Indian
software industry, splits a large software development of maintenance project
into two classes of activities:
• the first set of activities, called “on-site activities, has a very high level of
interaction between the client officers and the staff of the Indian
software company; and
• the second set of activities, called “off-shore” activities, includes
activities like functional design, detailed technical design, architecture,
database design, programming, testing, etc.
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3.3.3 It is also claimed that sometimes, the talent required for “on-site” tasks
may be requisitioned by a company from any of its offices anywhere in the
world based on the need of the expertise and this is what the Global Delivery
Model is all about. Another assertion is that sometimes, a pilot project may
have to be done exclusively “on-site” to establish the credibility of the Indian
software export. Therefore, the contention is that “on-site” activities are also
export activities generating hard currency revenue for India.
3.3.4 Industry emphatically argued that denial of tax holiday to several units
by the tax authorities deriving profits from “on-site” services, on the ground that
no export has been made out of the unit is also contrary to the express
provisions of the statute, as no such restrictive condition is found in the
substantive provisions of Section 10A, 10AA and 10B of the Act. They draw
support from, Explanation 3 to Section 10A, Explanation 2 to Section 10AA and
Explanation 3 to Section 10B.
3.3.5 Additionally, they have contended that CBDT’s circular no. 694 of 1994
creates uncertainty since it provides that the “on-site” software development
will be considered as export only if the software is ‘actually’ the product of the
unit.
The officers of CBDT were of the view that the “on-site” services should have
some nexus with the unit claiming the deduction. They opined that 100% on-
site work defeats the purpose of exports out of India. They also relied on
Circular no. 694 of 1994.
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• These Explanations create a fiction that even when the activities are
carried “on site” i.e., outside India, the income there from is deemed to
be derived from export. The Committee recommends that deeming
fiction created by these Explanations must be given effect to and
income from “on site” development pursuant to contract between the
Indian entity and the overseas client for the development of software,
should be considered as derived from export.
• Circular No. 694 of 1994 has been partially rendered otiose after the
insertion of the deeming fiction in the above stated Explanations and
should be modified immediately by deleting the portion relating to
“development of programmes on-site”.
• In cases where deduction has been denied and the taxpayer is before
the CIT (A) or DRP, the issue may be allowed to be decided by the CIT(A)
or DRP in accordance with the law and the Assessing Officers should be
directed to either concede the issue or not contest the same further.
• In cases where the CIT(A) or ITAT or High Court has decided this issue in
favour of the taxpayer, no further appeal should be filed by Revenue.
Wherever Revenue has already filed further appeal on this issue before
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the ITAT, High Court or Supreme Court, as the case may be, the relevant
ground of appeal may be withdrawn immediately.
The Industry representatives have stated that the tax authorities have denied
tax holiday to several units by alleging that deployment of manpower to “on-
site” locations is a case of “body shopping” and no benefits can be given for
such activities. The stakeholders have asserted that Deployment of Technical
Manpower [DTM] is for the purpose of software development abroad and
receipts from such activities are eligible for deduction under the Income-tax
Act.
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• In cases where deduction has been denied and the taxpayer is before
the CIT(A) or DRP, the issue may be allowed to be decided by the CIT(A)
or DRP in accordance with the law and the Assessing Officers should be
directed to either concede the issue or not contest the same further.
• In cases where the CIT(A) or ITAT or High Court has decided this issue in
favour of the taxpayer, no further appeal should be filed by Revenue.
Wherever Revenue has already filed further appeal on this issue before
the ITAT, High Court or Supreme Court, as the case may be, the relevant
ground of appeal may be withdrawn immediately.
3.10 Issue 3: Taxation of new SEZ units – whether hiring of new employees is a
condition for eligibility to claim deduction under Section 10AA
3.11.1 The industry explained that tax incentive u/s 10A of the Income-
tax Act came to an end on 31/3/2011. Thus, STPI units are no longer eligible to
claim any tax benefit. On the other hand, SEZ units in the software
development segment have a 15 year tax holiday available to them u/s 10AA
of the Act.
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3.11.2 The stakeholders from the industry do agree that tax authorities rightly
deny the benefit when taxpayers move all their business to the SEZ unit from
their existing STPI unit to claim the tax incentives. However, industry has
emphatically stated that the movement of personnel from STPI units is
necessary as every project needs experienced project managers, analysts,
programmers, etc. and it was impossible for a software company to do
projects only with freshers. Further, the submission was that re-skilling of
employees, addresses underemployment and results in incremental activity
which generates economic rewards in the system .The view of the industry is
that since there is no requirement of the law as contained in Section 10AA to
have only new employees in the SEZ unit, tax authorities should not deny the
tax benefits on this ground. They have also relied upon Instruction No. 70,
dated 9th November, 2010, issued by the Department of Commerce in which
the latter has clarified that there was no limitation on the movement of
manpower from STPI/DTA units to SEZ units.
The officers of CBDT were of the view that there should be a certain
percentage of new employees in the new SEZ units to make those units eligible
for claiming this deduction. However, they also appreciated that there was no
such explicit requirement in the current provisions of Section 10AA.
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• In cases where deduction has been denied and the taxpayer is before
the CIT (A) or DRP, the issue may be allowed to be decided by the CIT(A)
or DRP in accordance with the law and the Assessing Officers should be
directed to either concede the issue or not contest the same further.
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• In cases where the CIT(A) or ITAT or High Court has decided this issue in
favour of the taxpayer, no further appeal should be filed by Revenue.
Wherever Revenue has already filed further appeal on this issue before
the ITAT, High Court or Supreme Court, as the case may be, the relevant
ground of appeal may be withdrawn immediately.
3.15.1 The representatives of the industry in the IT sector have stated that
when an Indian software exporter is empanelled by a foreign client for
developing software from time to time, the first activity that happens is the
negotiation of a Master contract between the client and the Indian software
exporter. This is known as a Master Service Agreement [MSA]. Generally, this
MSA covers issues like duration of the master contract, the rate per hour of
work, liability clauses, agreement not to poach each other’s staff, loaning of
technology, IP protection, etc. This process is a long-drawn process and could
take anywhere between two months to one year. Once this MSA is signed, the
client informs the business groups that they are now free to issue a Statement
of Work [SoW] for a specific piece of software development.
3.15.2 The stakeholders have pointed out that some tax officials are not
accepting the SoW and are insisting that the client must issue a fresh MSA for
every assignment taken up by an eligible Indian software exporter for a foreign
client. They argue that this is not feasible because clients do not see any value
in doing this since all clauses of the MSA have already been agreed upon after
lengthy negotiations involving purchase and legal people from either side.
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The officers of the CBDT were of the view that the SoW should not be the
deciding factor but the MSA should be. They contended that if the MSA was
old then the deduction should not be allowed, as the SoW could be
prematurely terminated and the business transferred to the eligible unit
through a new SoW, thereby defeating the legislative intent of encouraging
incremental export activity.
• The Committee is of the view that the SoW should be above the MSA in
the hierarchy of legal/commercial documents for the purposes of
determining the actual work being done.
• Since the SoW lays down the actual scope of work and the software
development is carried out in accordance with the terms of the SoW, it is
the SoW that should be given primary importance and not the MSA for
the purposes of tax incentives under Sections 10A, 10AA and 10B. The
fact that an SoW has been issued under an existing MSA would not be
detrimental to the claim of deduction by an taxpayer.
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• In cases where deduction has been denied and the taxpayer is before
the CIT (A) or DRP, the issue may be allowed to be decided by the CIT(A)
or DRP in accordance with the law and the Assessing Officers should be
directed to either concede the issue or not contest the same further
subject to the taxpayer furnishing a certificate from the management to
the effect that the new SoW has not been brought into existence by
prematurely terminating an old SoW covering the same work.
• In cases where the CIT(A) or ITAT or High Court has decided this issue in
favour of the taxpayer, no further appeal should be filed by Revenue.
Wherever Revenue has already filed further appeal on this issue before
the ITAT, High Court or Supreme Court, as the case may be, the relevant
ground of appeal may be withdrawn immediately. However, these
actions by the Revenue would be subject to the taxpayer furnishing a
certificate from the management to the effect that the new SoW has not
been brought into existence by prematurely terminating an old SoW
covering the same work.
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3.18 Issue – 5: Tax incentives not available to R&D activities in STPIs, SEZs and
EOUs, as it is not an eligible activity - Denial of tax holiday under Sections 10A,
10AA and 10B, respectively, in mid-course on the eligibility criterion on this
issue.
3.19.1 The stakeholders from industry pointed out that tax holidays, once given,
should not be denied mid-course on the ground that R & D activities were not
eligible, as it created uncertainty and sent out negative signals. Their argument
is that R & D activities are IT enabled services covered under the term
‘customised electronic data’ and also under the products and services
notified by the CBDT in Notification No. 890(E), dated 26/9/2000.
3.19.2 They requested that it should be clarified that R&D centres set-up as
STPs, SEZs or EOUs should be allowed deduction u/s 10A/10AA/10B. Further,
wherever additions have been made or cases have been re-opened, all such
actions should be withdrawn and relief granted to the taxpayers by means of
a circular.
Sections 10A, 10AA and 10B provide tax benefit for export of articles or things
or computer software. Scientific R & D does not come within the IT enabled
services notified by the CBDT expanding the scope of “customized electronic
data or any product or service of similar nature”. Besides, original research and
development is not included as a part of customized electronic data or
services of similar nature. If scientific research and development had been
notified as a service similar to export of customized electronic data, it would
have been a different matter.
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3.22 Issue – 6: Deduction under Section 35(2AB) of the Income-tax Act should
be extended to computer software
The industry asserted that since a lot of R & D activity was carried out in the
software segment, it may be clarified that beneficial provisions of Section 35
(2AB) allowing a weighted deduction to the eligible entities, should be
extended to the IT sector.
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The Committee notes that Section 35(2AB) of the Act refers to manufacture or
production of any article or thing and the term “computer software” is missing.
The Committee is of the view that if the legislative intent was to cover computer
software also, the language would have been similar to the language used in
Sections 10A, 10AA i.e “articles or things or computer software”. The
Committee, therefore, recommends that having regard to the provisions as
currently worded, no clarification is necessary.
3.26 Issue – 7: Tax holiday under Sections 10A / 10B denied to the transferee
on transfer of undertaking under slump sale
3.27.1 The representatives of industry pointed out that tax holiday under
Sections 10A/10AA/10B is undertaking specific and hence any business
reorganisation which results in the transfer of the entire undertaking should
entitle the purchaser to claim tax holiday benefits for the unexpired period of
tax holiday claim.
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Revenue denies the tax holiday on the grounds that the undertaking is formed
by splitting up of an existing business or that the assets had been used earlier.
They also argue that there is no specific provision in Sections 10A, 10AA or 10B
which allows the deduction to be given for the unexpired period post such
slump sale, while such a provision is there for amalgamation and demerger.
• The Committee is of the view that the tax benefit is attached to the
undertaking and not the taxpayer (owner of the undertaking) and is also
of the view that the undertaking post slump sale is not one that has been
formed by splitting up or reconstruction of an existing business. Several
judicial decisions have also upheld these views and disagreed with the
Revenue’s stance of disallowing the tax benefit to the owner of the
eligible undertaking post such slump sale. Therefore, the Committee
recommends that in case of a slump sale of an eligible undertaking as a
going concern, the tax holiday for the unexpired period should be
available to the owner of the eligible undertaking post such slump sale.
• In cases where deduction has been denied and the taxpayer is before
the CIT (A) or DRP, the issue may be allowed to be decided by the CIT(A)
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or DRP in accordance with the law and the Assessing Officers should be
directed to either concede the issue or not contest the same further.
• In cases where the CIT(A) or ITAT or High Court has decided this issue in
favour of the taxpayer, no further appeal should be filed by Revenue.
Wherever Revenue has already filed further appeal on this issue before
the ITAT, High Court or Supreme Court, as the case may be, the relevant
ground of appeal may be withdrawn immediately.
The industry has pointed out that there being no such requirement in the Act,
taxpayers have been computing profits derived by undertakings from exports
on the basis of profit/cost centre data culled out from their respective ERP
systems. Accordingly, they requested, it may be clarified that there is no such
requirement and tax incentives cannot be denied on this ground.
The deduction under Sections 10A/10B is given “eligible undertaking” wise, and
not ‘eligible business’ wise. The profits of the “eligible undertaking” will also
have to be certified by a Chartered Accountant as per specified audit form.
In view of the same, the “eligible undertaking” has to necessarily maintain
separate books of account for the profits of the eligible unit to be determined
and for the accountant to certify the said profits. Besides, under the STPI rules,
separate books of account are required to be maintained.
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• The Committee is of the view that the Revenue cannot deny deductions
under Sections 10A, 10AA or 10B on the ground of non-maintenance of
separate books of account for the eligible unit, as there is no
requirement in law to maintain separate books of account. The
Committee also took note of the provisions of Section 11 of the Act,
wherein there is a specific requirement in sub-section (4A) for
maintenance of separate books of account by a trust or institution in
respect of profits and gains of business, which is incidental to the
attainment of the objectives of such trust or institution.
• In cases where deduction has been denied and the taxpayer is before
the CIT (A) or DRP, the issue may be allowed to be decided by the CIT(A)
or DRP in accordance with the law and the Assessing Officers should be
directed to either concede the issue or not contest the same further.
• In cases where the CIT(A) or ITAT or High Court has decided this issue in
favour of the taxpayer, no further appeal should be filed by Revenue.
Wherever Revenue has already filed further appeal on this issue before
the ITAT, High Court or Supreme Court, as the case may be, the relevant
ground of appeal may be withdrawn immediately.
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3.35.1 The industry has represented that the Revenue has been contending
that -
• the reimbursement by the Indian company of the salaries of the
employees deputed to it by the overseas affiliate is in the nature of Fees
for Technical Services (‘FTS’) and is liable for TDS under Section 195 of
the Act;
• the overseas affiliate seconding the employees to the Indian company
is the real employer and that the overseas affiliate provides services to
the Indian company through its employees and hence, the payments
are chargeable as FTS in India.
3.35.2 The other worry for the industry is that such a contention by the
Revenue might lead to potential disallowance under Section 40(a) of the Act
in the hands of the Indian company for non-deduction of tax at source.
The Revenue’s contention is that the overseas affiliates are the real employers
of the secondees under the secondment agreements and that the Indian
entities only assumed the role of intermediaries who were authorized by the
real employers to exercise supervision and control over the seconded
employees during the period of secondment. Further, the Revenue claims
that since the secondees were employees of overseas affiliates and were
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providing managerial services to the Indian entities, the payment made by the
latter to the former under the secondment agreements constituted ‘Fees for
technical services’ under Section 9(1)(vii) of the Act. The Revenue, therefore,
believes that the Indian entities are liable to deduct tax under Section 195 of
the Act in respect of reimbursements made to the overseas affiliates under the
secondment agreements and where no tax is deducted, the entire payment
made by the Indian entities is liable to be disallowed under Section40(a)(i) of
the Act.
3.39.1 Industry has pointed out that in the absence of a definition to the term
‘total turnover’, the Revenue has been ignoring the legal intent of the
provisions and does not provide parity of treatment between the term export
turnover and total turnover and the items which are excluded from the export
turnover are not being excluded from the total turnover. This results in the
reduction of the tax holiday available to the IT companies.
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application of the said formula, the extent of profit eligible for the relief gets
artificially reduced.
The contention of the Revenue is that while freight and insurance charges are
to be excluded in computing export turnover because export turnover has
been defined in the Income Tax Act and there is a specific exclusion of freight
and insurance, a similar exclusion has not been provided in regard to total
turnover.
• The Committee is of the view that the formula for computation of the
profits eligible for deduction under Sections 10A, 10AA and 10B cannot
be altered without explicit provision in law in such a manner so as to
artificially reduce such eligible profits. Therefore, the Committee
recommends that whenever certain items of expenses or receipts are
removed from the export turnover, the same items of expenses or
receipts should also be removed from the total turnover to ensure parity
between the numerator and the denominator.
• In cases where the CIT(A) or ITAT or High Court has decided this issue in
favour of the taxpayer, no further appeal should be filed by Revenue.
Wherever Revenue has already filed further appeal on this issue before
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the ITAT, High Court or Supreme Court, as the case may be, the relevant
ground of appeal may be withdrawn immediately.
3.42 Issue – 11: Denial of tax holiday on transfer of an eligible SEZ unit from
one SEZ to another SEZ
3.43.2 However, Revenue authorities are construing that the newly shifted
unit would be understood to have been formed by way of splitting up or
reconstruction of the existing SEZ unit and hence questioning the allowability of
the tax holiday claim in such cases.
3.43.4 Industry has asserted that a unit may intend to shift from one SEZ to
another due to certain operational difficulties faced by it such as, availability
of people, space, desired location, etc.
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Revenue denies the tax holiday on the ground that the undertaking is formed
by splitting up as the assets have been used earlier.
• The Committee is of the view that the tax benefit is attached to the
undertaking and, therefore, movement of an eligible SEZ unit from one
SEZ to another should not be to the detriment of the unit.
• In cases where deduction has been denied and the taxpayer is before
the CIT (A) or DRP, the issue may be allowed to be decided by the CIT(A)
or DRP in accordance with the law and the Assessing Officers should be
directed to either concede the issue or not contest the same further.
• In cases where the CIT(A) or ITAT or High Court has decided this issue in
favour of the taxpayer, no further appeal should be filed by Revenue.
Wherever Revenue has already filed further appeal on this issue before
the ITAT, High Court or Supreme Court, as the case may be, the relevant
ground of appeal may be withdrawn immediately.
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New units are expansion of the existing undertaking and therefore are eligible
for tax deduction only for the balance period available for the existing
undertaking.
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• In cases where the CIT(A) or ITAT or High Court has decided this issue in
favour of the taxpayer, after examining the eligibility of the taxpayer for
these deductions, no further appeal should be filed by Revenue.
Wherever Revenue has already filed further appeal on this issue before
the ITAT, High Court or Supreme Court, as the case may be, the relevant
ground of appeal may be withdrawn immediately.
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APPENDIX – A
NASSCOM data shows that at present more than 750 DCs are working from
India, 28 per cent of them with multiple locations and DCs contributed around
1/3rd of total IT export revenues of $68 billion in the fiscal 2012. They account for
22 per cent of IT-BPO export revenues and 21 per cent of employees 6.
Export revenue from IT/BPO Industry FY 2012
35%
65%
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• The industry has significantly grown over the last 5 years and currently
has representation from most of the verticals like Aerospace & Defence,
Automotive, BFSI, Bio-Technology, Chemicals, Computer Hardware,
Education, Electronic/Electrical Equipment, Energy, Healthcare,
Industrial, Semiconductors, Software/Internet, and Telecommunications,
etc 9.
• Manufacturing focussed verticals such as Automotive and Construction
/ Heavy Machinery were some of the first industries to engage in ER&D
off shoring and now have a mature supply base in India.
• Cost pressure, access to flexible capacity, local market access for
growth and decreasing time-to-market were some of the key reasons
driving off shoring in those industries. But the most important factor is the
availability of large pool of skilled manpower in terms of scientists,
engineer etc.
8 NASSCOM - http://www.nasscom.in/global-inhouse-centres
9 NASSCOM - http://www.nasscom.in/global-inhouse-centres
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200
100
0
Before '00 01-02 03-04 05-06 07-08 09-11
A Research paper by IIM-A indicates that other countries with similar growth in
R & D include China, UK, Germany, Brazil, Russia, etc.12.
12
IIMA (2012): Foreign R & D centres in India
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Annexure I
PM sets up committee to review Taxation of Development Centres and the IT Sector, Safe
Harbour Provisions to be Finalised soon
The Prime Minister has constituted a Committee to Review Taxation of Development Centres and the
IT Sector. The Committee will engage in consultations with stakeholders and related government
departments to finalise the Safe Harbour provisions announced in Budget 2010 sector-by-
sector. It will also suggest the approach to taxation of Development Centres.
2. The Prime Minister had earlier set up an Expert Committee on GAAR under the Chairmanship of
Dr. Partho Shome to engage in a widespread consultation process and finalise the GAAR Guidelines.
The response has been overwhelmingly positive.
3. While this committee would address concerns on GAAR provisions and would reassure investors
about the predictability and fairness of our tax regime, it was felt that there is still a need to address
some other issues relating to the taxation of the IT Sector such as the approach to taxation of
Development Centres, tax treatment of "onsite services" of domestic software firms, and also the
issue of finalising the Safe Harbour provisions announced in Budget 2010.
4. Many MNCs carry out activities such as product development, analytical work, software
development, etc. through captive entities in India. They exist in a wide range of fields including IT
software, IT hardware, Pharmaceutical R&D, other automobile R&D and scientific R&D. These are
popularly called Development Centres. Over 750 MNCs have such centres at over 1100 locations
in India. The reason for this large concentration of Development Centres in India is the worldwide
recognition of India as a place for cost competitive, high quality knowledge related work. Such
Development Centres provide high quality jobs to our scientists, and indeed make India a global hub
for such Knowledge Centres. However, India does not have a monopoly on Development Centres.
This is a highly competitive field with other countries wanting to grab a share of the pie. There is
need for clarity on their taxation.
5. As far as Safe Harbour provisions are concerned, these were announced in Finance Bill 2010
but have yet to be operationalised with a wide application. Safe Harbour provisions have the
advantage of being a good risk mitigation measure, provide certainty to the taxpayer.
6. The resolution of the above tax issues requires a comprehensive approach in which other
government departments are consulted and industry bodies are taken on board. The overall goal is
to have a fair tax system in line with best international practice which will promote India's software
industry and promote India as a destination for investment and for establishment of Development
Centres. Therefore, the Prime Minister has constituted a Committee consisting of experts from the
Income Tax Department, both serving and retired, who will examine the issues in detail and submit
proposals in a short time. An arm’s length exercise of this nature will allay a lot of concerns in
addition to the immediate resolution of issues that is necessary.
7. For this purpose, a Committee on Taxation of Development Centres and the IT sector has
been constituted consisting of:
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4) Any other officer from the Income Tax Department to be co-opted by the Chairman
i) Engage in consultations with stakeholders and related government departments to finalise the
approach to Taxation of Development Centres and suggest any circulars that need to be issued.
ii) Engage in sector-wide consultations and finalise the Safe Harbour provisions announced in Budget
2010 sector-by-sector. The Committee will also suggest any necessary circulars that may need to be
issued.
iii) Examine issues relating to taxation of the IT sector and suggest any clarifications that may be
required.
i) Finalise the approach to taxation of Development Centres and suggest any necessary clarifications
by 31 August 2012.
ii) Suggest any necessary clarifications that may be needed to remove ambiguity and improve clarity
on taxation of the IT Sector by 31 August 2012.
iii) Finalise Safe Harbour Rules individually sector-by-sector in a staggered manner and submitting
draft Safe Harbour provisions for three sectors/sub-activities each month beginning with the first set
of suggestions by 30 September 2012. All Safe Harbour provisions can be finalised by 31
December 2012.
10. The Department of Revenue will provide all necessary support to the Committee to facilitate its
work including office assistance and assistance to facilitate consultations.
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Annexure II
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Annexure III
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Committee to Review Taxation of Development Centres and the IT Sector
Annexure IV
The Union Finance Minister, Shri P. Chidambaram has said that uppermost in
his mind is the duty to re-gain the confidence of all stakeholders. Assuring that
inflation can be moderated in the medium term, he said that the Government will
work with RBI in this regard. In a statement, the Finance Minister said that a
path of financial consolidation will be unveiled shortly. He made it clear that the
burden of fiscal correction must be shared, fairly and equitably, by different
classes of stakeholders. The Finance Minister said that the poor must be
protected and others must bear their fair share of the burden. He further said
that wherever required, the corrective measures will be taken in bringing clarity
in tax laws, to have a stable tax regime, a non-adversarial tax administration and
a fair mechanism for dispute resolution.
Price stability is an important objective. In fact, it is more important for the poor.
There has been pressure on prices, and inflation - especially food inflation - is
high. The causes are well known: some are beyond our control, such as prices of
crude oil and imported commodities, but some others can be addressed by
determined action. We will take steps to remove the constraints on the supply
side. We will also use our stocks of foodgrain to moderate prices. Where
necessary, we will enhance the import of items in short supply.
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the same direction and must move in tandem. Government will work with the
Reserve Bank of India to ensure that inflation is moderated in the medium term.
We are conscious that current interest rates are high. High interest rates inhibit
the investor and are a burden on every class of borrowers, be it a manufacturer
of goods or a purchaser of a home or a two wheeler or a student who takes an
education loan. Sometimes it is necessary to take carefully calibrated risks in
order to stimulate investment and to ease the burden on consumers. We will take
appropriate steps in this regard.
The key to restart the growth engine is to attract more investment, both from
domestic investors and foreign investors. Since investment is an act of faith, we
must remove any apprehension or distrust in the minds of investors. We will
improve communication of our policies to potential investors. The aim will be to
remove the perceived difficulties in “doing business in India”, including fears
about undue regulatory burden or regulatory over-reach. Indian companies,
especially public sector enterprises, which have large cash balances will be
encouraged to restart investment. Proposals pending with the Foreign Investment
Promotion Board will be processed and decisions taken expeditiously.
I believe that, around the world, there is enormous goodwill for India and most
people continue to keep faith with the India growth story. It is natural that they
look closely at certain economic indicators, one of them being the exchange rate.
Volatility of the exchange rate has reduced in recent weeks. A reassurance on the
investment climate, continued inflow of remittances, and a rise in capital flows –
both FDI and FII – will bring further stability to the exchange rate. We intend to
fine tune policies and procedures that will facilitate capital flows into India.
Manufacturing and exports are two key drivers of the economy. Both have
registered low or negative growth in recent months. It is imperative that we
reverse this trend. Supply side constraints upon manufacturing and exports
must be removed in double quick time. We intend to work with manufacturers
and exporters and implement appropriate short term and medium term
measures.
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Some sectors are under stress, for example, petroleum, electricity and textiles.
We intend to find practical solutions to the problems that impede higher
production or output in the coal, mining, petroleum, power, road transport,
railway and port sectors. The Cabinet Committee on Economic Affairs will
examine the issues affecting each sector and take decisions that will lead to
quantitative growth in these sectors.
Unfortunately, the south west monsoon has been below expectations. Drought-
like conditions have been reported from several States. It is the duty of the
Government to provide relief to the people living in drought affected districts,
protect wage employment and save agricultural production to the extent possible.
MGNREGA and other schemes will be converged to meet the challenge of
drought. Contingency plans are in place to supply drinking water and fodder and
to help farmers replant alternative crops. We must seize the opportunity to build
durable assets that will provide employment to the poor as well as help in
drought-proofing agriculture in the affected districts.
As I said at the outset, the Indian economy faces many challenges. We are
challenged by the global economy. We are challenged by the crisis that has
afflicted several leading banks of the world. We are challenged by natural
calamities such as floods in one part of the country and drought in other parts of
the country. Above all, we are challenged by our own record of fiscal
consolidation, high growth, moderate inflation and rise in human development
indicators that we achieved during 2004-08. Let us remember that we had faced
similar challenges in 1991, 1997 and 2008 and we overcame them. It is widely
acknowledged that, today, the Indian economy is stronger and better prepared to
face the challenges. Moderate growth in two out of eight years should not dent
our confidence.
Several legislative proposals have gone through the full deliberative process and
are ripe for debate and passing in Parliament. I seek the cooperation of all
political parties represented in Parliament to pass these Bills. With the
cooperation of political parties, civil society, farmers and workers, service
providers, producers and consumers, and scientists and technologists, I am
confident that we will prevail and we will return to the path of high growth,
inclusive development, and economic and social justice for all.”
*******
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Annexure V
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Annexure VI
A. Administrative Issues:
i. Higher margins adopted by the TPOs based on cherry picking of
comparables.
ii. Not applying a turnover range while choosing comparables.
iii. Conducting fresh search of comparables by the TPOs including use
of secret comparables by getting information under Section 133(6).
iv. Application of some additional filters like different accounting year
ending filter, employee cost filter, diminishing revenue filter and
significant activity (>75%) filter while searching for suitable
comparables in public databases like Prowess and Capital Line.
v. Rejection of filters applied by the assessee such as marketing
expenses to sales >3% and R&D expenses to sale >3%.
vi. Issue of risk adjustment, working capital adjustment and capacity
utilisation adjustments.
vii. Accounting issues of bank charges, foreign exchange fluctuation,
provision for bad & doubtful debts, etc.
B. Legal Issues:
i. Rejection of use of multiple year data and earlier data.
ii. Use of current year data and also use of data, which was not
available to the assessee at the time of TP documentation.
iii. Use of inter-quartile range instead of arithmetic mean.
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